Investing means we can liquidate our insights, which reflect our thoughts on the future and changes in industry trends.
We generally buy/sell stocks in the following 2 scenarios:
- Long a stock: stock price is undervalued and will rise significantly in the future
- Short a stock: stock price is overvalued and will decline significantly in the future.
However, in practice, stock seldom surges or plummets too much. The general 2 cases are:
- When stock price just go down a little bit, shorting will not bring gains.
In such a scenario, we can sell put or adopt bull spread strategy.
- When stock price won't rise sharply, the gain from being long the underlying stock is also small.
In this scenario, we can use a bear spread strategy. (bear call spread or bear put spread)
As I mentioned so many times:
Option are suitable for more scenarios and can help you make money in different scenarios.
1. Bear Put Spread Case Analysis -- $Alibaba(BABA)$
Let's look at an example of $Alibaba(BABA)$
Alibaba options page - bottom- bulk order:
Some traders bought/sold the large amount of baba put at the same time.
Let's guess, what kind of options did this institution or trader place?
My guess his strategy is bear put spread.
I guess he sell put of $ 180 and earned $90.85, and buy put of $190 and spent $99.8. His 2 orders together constitute a bear put spread.
If $Alibaba(BABA)$ share price <= 180 in Jan 23, 2023, then his gains = 10+90.85 - 99.8 = 1.05, break-even point is 181.05.
This spread actually earns the difference in the time value of the two puts, the time value of the 180 put is large and the time value of the 190 put is small.
He bet that $Alibaba(BABA)$ will not double by Jan. 2023. Even if he is wrong, the loss is limited.
2. Why Bear Spread Better Than Sell Naked Call
1. earn more: sell $Alibaba(BABA)$ call of 180 only has gains of 0.56. Bear put spread can help you earn 1.05.
2. less margin: sell naked call needs more margin, and the margin is unstable. As the stock price rises, the margin rises sharply. The margin of spread strategy is controllable.
3. limited loss: sell naked call's downside is worse. In case the stock surges 10 times, naked call loss is uncapped.
3. How To Place Orders In Practice?
1. When is the best time to place orders of bear put spread?
We can refer to the time of the Alibaba example. The trader chose to place orders when stock plunged.
Because the day of the plunge, iv will be higher, the two orders have more differences.
If he wants to earn more by using this strategy, he needs put of 180 has higher time value.
2. How to choose the strike price of A and B?
The higher A price means the greater security, also the less gain.
As long as the stock won't soar above the break-even point between A and B, he will make money.
But the higher A means the smaller difference in time value, the gains will also be less.
Bottom Line
Note: Bear put spread strategy is more suitable for large companies, small cap companies are prone to large fluctuations. Large-cap companies have better option liquidity and are more suitable for this type of operation.
Can you think of any large-cap companies that are suitable for bear spreads? Feel free to comment.
To learn more about my series for beginners- Options Insights, you can click:
Options Insights III: What is Cash-Secured Puts (TSLA, QQQ, PDD)
Options Insights IV: The Downside of Cash-Secured Puts
Options Insights VI: The Advantages of Cash-Secured Puts
Options Insights: Criteria For Selecting Long-Term Target & Recommendations
Options Insights II : Why choose QQQ over SPY?
Options Insights: A Good Time to Sell Put of TSLA & TENCENT Now
Options InsightsⅤ: Why GOOG is a good choice for sell put?
Options Insights VII: How To Trade Apple After Its Earnings?
Options Insights Ⅸ: How to Control Risk? Technically & Mentally
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